Periods of market volatility have often been followed by renewed strength in quality stocks, and today’s market is no exception – creating a compelling opening for US small and mid-cap (SMID) companies.
Firms with strong balance sheets, consistent profitability and disciplined capital allocation have been shown to deliver superior long-term returns. While these companies are not immune to downturns, history has shown that robust and sustained recoveries often follow.
Let’s consider the five largest drawdowns for the MSCI US Quality Index (Figure 1). These defining episodes – September 1990, August 1998, July 2002, the 2008 Global Financial Crisis (GFC) and the onset of the Covid-19 pandemic in early 2020 – coincided with major market dislocations. Quality stocks experienced sharp declines, yet their subsequent recoveries proved to be remarkably strong, with three-year returns frequently exceeding 50–100%.
Figure 1: Quality bounces back
This mirrors the longer-term relative outperformance of quality, as shown in Figure 2. While there are periods of pullback – most recently in 2020 and 2025 – a conclusive and reassuring ‘bottom left to top right’ trend is evident.
Figure 2: Relative performance of US Quality Index vs. broad MSCI US Index
With moderating inflation, an anticipated shift to lower rates and with earnings for US SMID stocks expected to be greater than their large-cap peers and the ‘Magnificent Seven’, we believe the stage is set for quality stocks to regain market leadership in 2026.
However, quality should not be treated as a short-term tactical allocation after periods of weakness but rather a strategic long-term play. Over time, these names have demonstrated an ability to deliver returns and their conservative characteristics become even more valuable during economic uncertainty. We believe a quality strategy is not just about weathering storms – it’s about positioning portfolios for durable growth and superior risk-adjusted returns across all phases of the cycle.
Conclusion
History rarely repeats, but it often rhymes. With markets having arrived at a critical juncture and structural tailwinds in place, now is the time to make US quality stocks – and particularly SMID quality – a strategic cornerstone of long-term portfolios. Not merely as a safe harbour, but as a driver of sustainable growth.
For more information on US SMID Equity.
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